Internationalization means for many companies just export and import. If it is possible to identify mobile (=not bound to a location) and value-added functions and to transfer them abroad, it is possible to improve the cost structure, to reduce personnel costs, to increase confidentiality and reduce taxes. Sometimes there are other legal benefits.
Company Structures: shall be designed based on future requirements, taking into consideration the existing situation and the goals of the owners. Structures cannot fit all desired purposes, and as the environment constantly changes (tax laws, business strategy and profitability, private situation), the structures should be flexible and allow a quick exit.
Here are some suggestions:
Subsidiary or sister company can take over certain functions of a company in another country. When implementing, it is important to avoid activities that would lead tax authorities to claim a closure of an operation and therefore to assume taxable profits on the hidden reserves which are the difference between actual value and book value (e.g. from selling a customer base).
If there are transactions between associated enterprises, transfer pricing should be documented and meet criteria of third party comparison. If consolidation is not required, a different accounting year can be an advantage.
Branch office: here a company sets up a branch which is part of the same legal entity, but constitutes a separate tax subject in the other country. A branch has no capital, the objects can differ from those at the main seat. Depending on the countries, it can act as a holding (also for purposes of Double Tax Treaties), have its own silent partners, it can merge with another company (“splitting”) and in many cases it can be closed easily. Most countries do not charge a branch remittance tax, some other countries charge tax depending on the country of the main seat (e.g. US, Spain).
The financial statement of the branch is created separately and then included into the financial statement at the main seat of the company. The tax authorities in the country of the main seat sometimes demand insight into the financial statement of the branch, but because of the double taxation agreements, there are attractive design options. The requirements for publication of accounts of a branch depend on the requirements at the main seat, so an EU branch of a Swiss company does not need to publish the accounts. Another advantage: in many cases it is possible to define a branch as new contracting partner (instead of the main seat) without changing contracts and without obtaining for consent of the other contracting party.
Atypical Silent Partnership (sometimes called Secret Partnership) an active silent partner joins a company based on a civil law contract that defines his contribution and his share of profits, losses and hidden reserves. The share of results can be based on total profits or on profit center results. If the company is active and has substance, the share of the profit qualifies as business income that is taxed only in the source country. There is a high level of confidentiality, because the silent partner is not shown in public registers, and there is only a clearing account in the accounting of the company. This structure may be useful if the source country has lower taxation than the residence country.
Typical Silent Partnership a silent partner can join a company in a pure financing role based on a civil law contract that defines his contribution and his share of profits. The latter can be based on total profits or on profit center results. In the source country, his share of profits can qualify (depending on circumstances) as interest expenses, which will be taxed in the country of the silent partner. There is a high level of confidentiality, because the silent partner is not shown in public registers, and there is only a clearing account in the accounting of the company. This structure may be useful if the source country has higher taxation than the country of the silent partner and if the investment object has little movable income or movable costs.
Intermediate companies operate between the parent company and sales or purchasing companies, they perform active functions and enable legal profit transfer. Sometimes they are set up to avoid discussions with customers who would not accept invoices from certain countries. They can also help to avoid withholding taxes (“Treaty shopping” or “Forum Shopping”)
Service companies may act as external body, while commercial activities are performed directly between headquarter and subsidiaries. They offer assistance in marketing, logistics, controlling, administration or management. If they take some risk, transfer prices can be higher.
Licensing companies: the licensor or franchisor are owners of trademarks, patents, licenses, software licenses, operational know-how, copyrights, etc., and use such intellectual property by offering to third parties the right to use it and to exploit it economically. Remember: some tax authorities require from the licensee the deposit of a copy of the license contract together with a tax residence confirmation of the licensor. This has to be handed in shortly after signing the contract.
Holding, Investment and Finance companies: they can use tax benefits and capitalize from access to capital markets. Investors in private equity often prefer to have their money back in the country of the holding after an exit deal.
Note: Criteria for a location for holding companies in our point of view:
a) tax free receipt of dividends from a subsidiary, even from a country with low taxation.
b) no withholding tax on transfer of dividends to a parent company.
c) double taxation agreements that prevent withholding taxes in the country of the subsidiary.
d) no tax on dividends at shareholder’s level.
e) no tax on capital gains (sale of companies or of shares).
f) Compliance inexpensive and non-complicated
g) No requirements for consolidation or audit
h) Low cost of services
i) Qualified (English speaking) employees available
j) Good transport connections
Countries like Switzerland only meet some of these criteria, thus there is a need to combine activities with active companies in other countries. In this field Zugimpex provides support.
Commercial broker: the broker is entitled to receive a commission if the principal and a third party to whom the broker acted as an intermediary, close a contract. He can look for a contracting party but has no obligation to act. He might get his commission for establishing a contact or be involved in contract negotiations. Often, commission claims arise only after the payments of the underlying contract has been completed.
Agent: the agent works permanently for the client and there is a continuing obligation, because the agent is obliged to act for the principal. For tax purposes there is an important difference between agents who have power to conclude sales (and constitute a permanent establishment according to Art. 5 DTT) and agents, who only initiate a deal, lead the contract negotiations and submit the documents to the principal for approval. In addition to commissions, agencies can receive various forms of compensation: commissions for collection, contingency commission, compensation for lost profits, compensation for a client stock or compensation for a non-competition clause.
Commission agents transact in its own name on behalf of others (corresponding to an art gallery that sells art works in its own name, but the art works belong to an artist who made them available to the gallery). The commission agent must comply with the requirements of the principal, and he gets a commission if he manages to close a deal. This forms of cooperation are also possible in service sectors.
Representative, exclusive representative agreements: rights and duties are strictly regulated, sometimes there is a definition of the region, sometimes there are obligations for minimum quantities or down payments for the customer base, if the contract is terminated. In many countries this is mandatory.
Joint Venture (Participating transaction): several parties agree to undertake a transaction in the name of one party but on joint account. Sometimes the joint venture does not appear to the outside, only internally. The partners notify each other of any third party transactions. In their accounts, the partners use one account for the joint venture transactions and one account for any other clearing partner. Such a structure is sometimes used in joint ventures in construction business, but also in other areas where one partner has a long term agreement that cannot be transferred to a third party (e.g. competition clause, general agent, contract after a tender). The “official” partner carries on the business in his own name, but shares his profit with the joint venture partners.
Franchise contract: the franchisee pays an initial fee and receives a temporary right to exploit a system and the right to be adequately trained on it. Usually, he continues to pay an ongoing fee to the franchisor, who maintains the system, and acquires the right of further support and participation.
Franchise contract: discretionary foundations can be installed in several countries, they are an attractive way to keep confidentiality and to protect assets. They qualify as discretionary if the founder and the beneficiaries have no influence on the board decisions and if the foundation is irrevocable. There is an expiry date for contestation, and some foundations can be redomiciled.
Sometimes a creative approach is better than the standard one:
- Founder: third-party acts as a founder and pays in the capital
- Beneficiaries: A nice group of people can be defined as beneficiaries, and they do not even need to know (please avoid politicians)
- Audit costs: are reduced or avoided if the purpose is not totally charitable
- Board: trustworthy persons, some jurisdictions require at least one local member
- Advisory Board with decision making powers, able to appoint or dismiss board members – the names are not shown in the public register
- The foundation has no bank account and does not make any contribution except a minimum to demonstrate compliance with the purpose
- Assets: foundation buys a holding company with the capital and has a liability of the remaining amount to the seller (alternative: to a company or to holders of a private bond)
- The management of the holding can be active and make significant decisions in the group
- Structure costs of such a foundation can be reduced to a very low level – only the local board member and the annual minimum- tax cannot be avoided.
Company Limited by Guarantee: this special UK structure has no capital and no shares, but a guarantee by a third party. It can act as a holding, can own real estate and may be interesting for people who live in countries where the national authorities control foreign investments and ownership in foreign companies.
Examples: combinations that fiscally make sense:
Use of different regulations for utilization of losses: losses may occur in other countries economically or fiscally (such as accelerated depreciation). If there are losses from a limited partnership, from foreign business income or from silent partnerships, such losses can sometimes be offset against profits in the same country or in another country.
If a double taxation agreement provides exemption method with progression reservation, this may create a negative tax basis in the same year in the other country and consequently avoid taxation there. In addition, in later years the losses can still be used against future profits in the source country.
Redomiciliation: if the legislation in the source country allows such a mechanism, it is possible to redomicile a company to another jurisdiction with more favorable accounting and tax laws. Then changes can be made, and later eventually it is possible to redomicile the entity back. This can be useful if certain costs are accepted in the target location, if hidden reserves can be activated or if there is an issue with a loan to a related party.
It is also possible to redomicile an offshore company to an onshore jurisdiction. Before this step accounting for the offshore company (according to the liberal regime) can be installed for past periods, and there are cases where large cost positions have happened so long ago that the period to retain documents has already expired.
Slovak limited partnership (k.s.) with a Swiss branch: advantages of company law and tax law are combined into a total package: the Swiss branch is subject to moderate Swiss taxation. It can also act as a holding, receive dividends from other states tax-free, even if they are not “subject to tax”. Furthermore, there is no tax on the profit from a sale of a subsidiary (“Capital gains tax shopping”).The establishment of such a structure requires little capital investment, there is no requirement for statutory reserves and no “thin Capital Rule” (where a high level of debt is not recognized for tax purposes); profits of the Swiss branch may be taxed in Switzerland and can be transferred tax-free to the main seat.
Financing- and intellectual Property Structures: a company in a high tax country can be financed by an (active) subsidiary in a tax-free state. Interest rate expenses reduce the profit in the high-tax country and create a tax free interest income in the financing country, where it is changed into a tax-free dividend to the parent in the high-tax country. In so-called “double dip” structures, it is possible to deduct interests twice if the parent company borrows money regionally to finance the tax free subsidiary with a deposit who then borrows the money back to the holding. Similar structures can be used to exploit intellectual property (licenses).
Partnerships: transparent taxation combined with Limited taxation: some countries qualify migrants as “residents without domicile” and tax them only on local income or on income remitted into the country. They do not tax foreign income that is not remitted. Some of them allow such advantages to companies, too. Often it is possible for nonresident persons to create a partnership with transparent taxation. If this partnership has substance, then the double tax treaty allocates the right to tax profits only to the source country. If parts of these profits then arise and remain outside the source country, this country will not tax them. Consequently, this structure may offer a completely tax free solution (e.g. Scottish LP, however the authorities recently impose restrictions on such options).
Partnerships: transparent taxation combined with Limited taxation: when international activities need a structure, debt financing allows to deduct interest rates at the source location and create interest income at the location of the financing entity. Interesting options are bearer bonds, convertible loans or warrants (options that can be separated from the basic loan agreement). Sukuk bonds pay profit, not interest, they are asset-based, not asset backed, and the owner is the special purpose vehicle. Such securities may have partial ownership of a property (built by the investment company and held in a Special Purpose Vehicle), and Sukuk holders can collect the property’s profit as rental income.
Transfer of Functions – Schedule: Step by Step:
Step 1 – Situation Analysis and rough planning
- Profit forecast of the company based on the existing operational structure.
- Determination of mobile income: of processes and functions that could be relocated, developing of options and simulation with legal, operational, financial and tax considerations.
- Calculation of costs and benefits of transferring functions: tax savings plus additional benefits by “Tax Effective Supply Chain Management” minus additional costs (for restructuring, for IT adaptation, for maintaining the structure and for additional processes)
- Target structure, roadmap and timetable (for 1-2 alternatives)
Step 2 – Involvement of stakeholders
- Integration of your tax expert and consideration of his proposals.
- Presentation to fellow partners and other decision makers
- Obtaining necessary approvals from customers or suppliers, e.g. with permanent contracts
- Verification of target structure, schedule and timetable
Step 3 – decision and implementation
- Decision for individual functions (eventually partial simulation)
- Detailed plans, processes and time schedule
- Establishing the first structures (legal, physical, IT, people …)
- Establishment of processes
Ongoing monitoring (target / actual comparison) and improvements